The Week That Was (26th September - 1st October, 2021)
"In the 90s, it was irrational exuberance. Now it may be irrational doom and gloom." Robert B. Reich
"In the 90s, it was irrational exuberance. Now it may be irrational doom and gloom." Robert B. Reich
The media loves two things: war and financial catastrophe.
The move in treasury yields and a rise in energy prices brought out the peanut gallery in full force this week.
One-hit wonder, Michael Burry, was quoted everywhere.
The Zero Hedge crowd said the end of the rally was imminent. (They’ve been saying that since 2009!)
Rising inflation/an energy crisis/ a stronger dollar (pick your poison) is now the cause of the next Lehman Brothers apparently.
I thought it was Evergrande?
It’s as if we have Post-Traumatic Stress Disorder 13 years on.
Yes, there are headwinds.
But it’s far too early for the rally to end with a bang!
Valuations are on our side
PE for Nasdaq in March 2000 was 107x.
And corporates were paying 7x (?) higher corporate rates then.
In the Nifty 50 era of the late 1960s and early 1970s, Coca Cola and Kodak were trading at 50x!
Today, Nasdaq’s PE is 25x-ish.
Interest rates remain very low on a historical basis.
That means higher corporate cash flow and a much lower discount rate for valuation calculations.
And the number of tech companies growing like weeds and spitting out cash is mind blowing.
In 2000, they had Pets.com.
In 2021, we have Shopify.
Even if rates ended up at 2%, it wouldn’t really impact the operating margin of stocks like Facebook or the burden on borrowers, be they individuals or corporates.
Let’s please, therefore, stop worrying about the end of the world.
Perhaps we should all listen to Tom Petty more: “most things I worry about never happen anyway.”
Interest rates matter
Janet Yellen made a point of stressing the impact of interest rates on average people this week:
People forget what low interest rates mean and under-appreciate what the Fed has done.
Short term interest rate moves mean nothing really.
Very low levels of interest rates mean EVERYTHING in the long run.
If the 10 year yield rises to 2%, 30 year mortgage rates will probably increase to 3.8%-ish.
That’s still very low as can be seen in the chart below:
Interest rates play a big role in terms of housing affordability.
People pay mortgage payments; they don’t pay house prices.
The chart below shows how homes were unaffordable in the early 1980s due to the very high mortgage rates despite house prices being significantly lower.
The only way we see a big decline in the market, I think, outside of a geopolitical event, would be if the Fed changed course on its interest rate policy.
For me, that’s highly unlikely.
People feel richer on average
Interestingly, mortgage debt is up USD$573bn from the peak during the housing bubble but as a percentage of GDP, it is at 49.6%, down significantly from the peak of 73.3% of GDP during the bubble. (www.calculatedriskblog.com)
A lot of homeowners have large equity cushions in their home.
House price (and stock price) rises have massively boosted wealth for many.
The Fed did that.
Why did Alan Greenspan get on the front page on Time Magazine while Jerome Powell has to deal with Elizabeth Warren rants?
Maybe we are too bearish on the Fed. I think they’ve done a great job since Covid.
More on that in a minute….
Your Hip Bone is Connected to Your Knee Bone….is that how it goes?
The world is MASSIVELY interconnected and supply chains are falling like dominos.
The good news is meaningful things are now happening.
One good example this week is:
Supply chain restructuring is surely one of THE themes for the next 5 years.
Things will suck for a while but they will get better.
The Dollar Store - let it die?
One victim of the supply chain problems is The Dollar Store.
They are the guys that sell cheap Chinese stuff to the working poor in towns across Middle America that are too small for Walmart.
The Dollar Store said it would be raising prices to $1.50 for the first time in its history.
It makes for a great headline but this is a classic example of demand curve moving to the right and the aggregate supply curve moving to the left because of a supply shock.
Adam Smith’s invisible hand eventually will rectify this when the supply chain problem eases. In other words, cheap Chinese goods will make their way through the ports.
The same thing has already happened with pork supplies in China and the lumber price globally. Adam Smith is an amazing operator if he’s allowed to get on with it.
Personally, I hope business models that thrive in deflationary times like The Dollar Store disappear.
The Dollar Store’s growth since 2008 are a sign that Mum and Dad with 2 kids, earning $50,000 a year combined, have no other option.
By the way, is that kind of family set up 50% of the US right now? It’s not far off, I think.
Is it therefore an issue if McDonald’s workers earn a bit more money?
Surely not!
Especially when billionaires, who don’t pay enough tax and who have had serious testosterone replacement treatment (you know who I mean), are flying into space!
Inflation is emotive
If you are unfortunately going thru a medical emergency in the US, you probably think it’s the Weimar Republic already.
If you are a first-time buyer, house prices make you feel the Fed has it all wrong.
If you are a consultant/tech guy/storyteller, it’s a lot cheaper to operate a business than it was in the past.
A consultant had to buy a telex machine in 1981 to communicate with overseas markets. In 2021, calls to the US are made for free on WhatsApp.
Inflation is an average of a number of inputs and, because of that, the average might not go up when your own bills rise short term.
This creates frustration with the FED.
But the Fed is tasked with leading the financial future of the US and the world, whether that’s a good thing or a bad thing.
And the Fed has decided that core inflation (core PCE) is the right benchmark to monitor.
Let’s please stop focusing on CPI all the time.
“Inflation is always and everywhere a monetary phenomenon.”
Monetary economist Milton Friedman made the above line famous after stating it in a talk he gave in India in 1963.
It was correct in 1963 as the Fed’s printing had a direct impact on inflation in the 1950s.
But that was because the US had little debt then.
That’s not the case now.
As debt increases, the velocity of money decreases.
Japan is the best example of that. It was “pushing on a string” from 1990 to at least 2013.
For a refresher course, please listen to any of Dr Lacy Hunt’s lectures.
He’s an ex Dallas Fed senior economist and is very good at explaining non-trivial issues.
Perhaps, that’s why deflation, not inflation, keeps really smart people like Janet Yellen, Haruhiko Kuroda and Christine Lagarde up at night.
That’s going to be important to remember as inflation noise will build over the next couple of months to a crescendo no doubt.
Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly, and applying the wrong remedies: Groucho Marx
Senate hearings remind me of Winston Churchill’s famous statement:
Elected officials often look unsophisticated (stupid?) compared to the non-elected mandarins.
Remember how Amy Conney Barret wiped the floor?
It is unsurprising therefore that Elizabeth “I’m a hammer, so give me a nail” Warren came across as hysterical this week when she grilled Jerome Powell, the Chairman of the Fed.
She made some big accusations.
Apparently Powell is “dangerous” and has made the banking sector less safe.
She is 100% wrong.
Banks are in great shape.
Perhaps they’ve never been in better shape.
Banks don’t lend.
That’s the problem.
The Bank of Japan had the same issue with the Japanese mega banks in the 1990s.
My guess is there are many heated conversations going on between the Fed and Jamie Dimon.
Jamie knows JP Morgan’s share price won’t hold up if the Fed goes the negative interest rate route like Europe and Japan. (Will he retire like Jack Welch did at the top? I think so. Who will his Jeffrey Immelt be?)
The value-growth mean reversion trade is discussed a lot at the moment amongst HFs I know but perhaps they should be planning for this mean reversion trade in the 2H of 2022:
Negative rates will come if labor conditions don’t improve.
ESG - Mao’s Great Leap Forward?
The Globalists of the 1920s would have loved the way the world has adopted all things ESG. Although it’s not on the same scale still as Chairman Mao’s effort to transform China’s economy, and hopefully not as disastrous, it has felt very top down driven.
That’s not necessarily a bad thing. It’s a sign of the times. We are entering an age of Big Government.
The results have actually been pretty good for EVs. This week Nio and Li Auto delivered record numbers of cars in China and we just found out Tesla delivered 241,300 vehicles in the third quarter, topping expectations.
But such top down driven “industrial policy” was bound to have a negative impact somewhere.
This is actually the first time in history we have moved to a less dense energy source AND it’s the first time a previous energy source will be phased out.
Problems are starting to emerge and all of a sudden energy shortages are appearing. I have no real view, to be honest, but it’s something to watch.
How much oil does OPEC have right now?
Will is be a head fake like Delta?
Time will tell. Energy stocks don’t tend to do well when the dollar is firm.
As always, best of luck trading this week. Please share my newsletter with anyone who you think might like it. Please keep sending me comments.
Best regards
Mateen
DISCLAIMER: None of this is financial advice. The opinions expressed are purely my own opinions and it is imperative for you to do your own research. They do not represent the views of any company I am associated with.